Interest Dilution and Damages as Contribution-Default Remedies in Failing LLCs and Partnerships

Failure is not an option—at least not until it happens. Starting a venture with the attitude that failure is not an option may reflect the American spirit, but the reality is that attitude alone does not control the fate of the venture—even if it did, events can change attitude, precipitating the decline of a once-promising idea. Market or other forces often affect whether a venture fails or succeeds, and failure is a definite possibility for most ventures. Advisors working with venturers in their euphoric, optimistic days of formation must maintain a realistic perspective and help them draft provisions of their entity documents that effectively address the possibility of failure. For instance, the preference for particular contribution-default remedies can change as a venture’s promise and condition change. Consider how the members’ preference for interest dilution and damages can change as the fortunes of a venture change. Recognizing such preferences should affect the venturers’ decisions as their advisors help them draft the entity documents. A recent case from the Delaware Superior Court and earlier cases from the Kansas Court of Appeals help illustrate the legal repercussions of drafting contribution-default remedies for LLC or limited partnership ventures that fail. The cases all considered contribution-default remedies in LLC operating agreements, but the principles should apply to limited partnership agreements as well.